Is The Tax Repeal Only Glitter And No Gold For MedTech?

The medical device tax suspension up to Jan 1, 2020, is one of the very few amendments that have garnered the maximum number of bipartisan votes in the House.

Since its enactment in 2013, the 2.3% tax has been quite a menace for the medical device industry. Per a statement by the Advanced Medical Technology Association lobbying group, the tax had a significant negative impact on medical innovation and employment. Considering this, the House placed a suspension on the tax from January 2016 to December 2017 only to bring it back on Jan 1, 2018.

But recently, the House came up with a $31-billion bill on tax cuts, which included the abatement of the infamous medical device tax.

While the MedTech fraternity has been cheering the latest repeal, the share price and net margin performance of the medical device manufacturers is showing a different story. Let’s delve deeper.

How Glitzy is the Repeal for MedTech?

Innumerable reports claim that the repeal will ramp up domestic production, increase hiring of skilled professionals and lower the nation’s overdependence on offshore production.

Further, MedTech bigwigs are expected to enhance the R&D, improve margins, launch products, reduce capital depreciation, invest in early-stage MedTech companies, execute clinical trials and in turn fuel the next generation of U.S. Medical-Device industry by reinvesting profits (tax savings).

Notably, Johnson & Johnson (NYSE:JNJ) shelled out a lump sum $180 million as medical device sales tax in 2014. Meanwhile, medical device giant Stryker Corporation (NYSE:SYK) reported net earnings of $1.14 billion and paid approximately $229 million as medical device excise tax in 2015 — nearly 16% of earnings (data from a Med Device Online report). If the tax didn’t exist, analysts believe the companies could have used the cash to expand and improve their pipelines.

This drew heavy criticism, compelling the Democrats and the Republicans to lift the tax.

History Says a Different Story

Since the tax was abolished in 2015-end, the companies were expected to rake in profits and also put up an impressive show on the bourses starting 2016. However, the price performance and margin trend contradicted expectations.

In fact, the tax repeal news created quite a stir amongst analysts back in 2016, dealing a blow to shares of medical device manufacturers. Our data shows that the broader Medical-Products industry has underperformed the S&P 500 market in the last two years. The industry’s 31.3% cuts a sorry figure in comparison to the S&P 500’s 34.5%.

Here we take a sneak peek at the net margin trend of companies since the last tax repeal. Although no single metric can determine the profitability of a business accurately, investors can count on net margin to get a fair idea of the amount of profit a company is making.

A declining net margin post the tax repeal amendment throws light on the enormous risks and costs associated with the R&D and compliance requirements of MedTech manufacturers. This also raises a question on how will the tax repeal provide an impetus to the MedTech space, if it could do nothing significant two years back.

5 Stocks Grappling With Declining Prices & Net Margin

Here we have five MedTech stocks that have witnessed significant margin contraction despite the tax repeal in 2015.

We would like to draw your attention to the share price and net margin performance of companies following the tax’s abolition in 2015.

Over the past two years, Medtronic plc (NYSE:MDT) has been observed to underperform the broader markets. As per the latest share price movement, the stock lost 7%, comparing unfavorably with the S&P 500’s gain of 35.4%.

The company has been facing escalating costs and expenses that are weighing on its margins. Also, the company’s reiteration of 2018 guidance despite the projection of favorable foreign currency translation fails to lift investors’ spirits.

Over the past two years, Henry Schein, Inc. (NASDAQ:HSIC) has underperformed the S&P 500 index. The stock has lost 18.8%. We are disappointed with the continued deterioration in the company gross, operating and net margins, thanks to higher cost of sales and expenses. Also, a tough competitive landscape and pricing pressure weigh on the stock.

The U.S. healthcare products and service distribution industry is highly competitive and consist principally of national, regional and local distributors. In the North American dental products market, the company faces stiff competition from Patterson Dental business of Patterson Companies Inc (NASDAQ:PDCO). and Benco Dental Supply.

DENTSPLY SIRONA Inc.’s (NASDAQ:XRAY) share price movement has been disheartening over the past two years. The company has lost 7.1% in the period. A lackluster margin trend over the same time frame indicates the company’s failure to garner profits post the tax repeal.

For the days to comeDENTSPLY expects gross and operating margins to remain flat to decline slightly from 2017 levels as underlying margin rate improvement is expected to be offset by adverse foreign exchange and target inventory equipment reduction.

Allscripts Healthcare Solutions Inc. (NASDAQ:MDRX) has underperformed the broader market in terms of price in the past two months. Notably, the stock has returned 5.2%, compared with the S&P 500’s rally of 35.4%. Further, the company’s margins have contracted significantly in the past two years.

Allscripts also expects a modest increase in operating expenses. The company faces sluggishness in the international market and competition from larger players.

Bruker Corporation (NASDAQ:BRKR) has underperformed the broader market in terms of price in the past two years. The stock has returned just 10.3%, much lower than the S&P 500 market. Further, the company’s margins have declined steeply in the past two years.

Bruker conducts 80% of its business in international markets. As a result, currency fluctuations continue to result in foreign currency transaction losses.

Will the latest MedTech tax overhaul paint a different picture for these stocks?

Will History Repeat Itself?

Our analysis clearly shows that the broader industry hasn’t reacted positively to the tax repeal amendment that was legislated in 2015. If we consider the repeal’s effect on the MedTech space, the trend is expected to continue this time around as well!

However, the MedTech industry has been favored by a massive change in consumer behavior lately. This coupled with changing market dynamics led to a dramatic transformation of the U.S. healthcare system over the last couple of years. This is evident from the rise in minimally-invasive surgeries, higher demand for liquid biopsy tests and use of IT for quick and improved patient care along with the shift of the payment system to a value-based model.

Further, the strategic application of Artificial Intelligence in every sphere of healthcare can provide boost productivity in the MedTech space. Companies that have adopted AI technologies witnessed a 50% reduction in healthcare costs and are expected to record strong margin expansion as well.

You never know, the current favorable trend might turn the tables for the MedTech industry!

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